Planning regular IRA contributions while you’re still working is an important part of building retirement security. The reason is twofold. First, if you typically spend your whole paycheck, you’ll get used to the lifestyle the whole check affords you, leaving no room for saving. Second, if you’re not saving for retirement, you have no hope of affording that lifestyle. Regular investing keeps your retirement lifestyle expectations reasonable and helps build the nest egg to support it when you stop working.

Most employer retirement plans (see Chapter 2) offer pre-tax contributions regardless of your income. This is a great benefit for tax savings now but can create tax issues after retirement. If your retirement income comes solely from Social Security or pension income, plus withdrawals from your retirement accounts, you could find yourself in the same high tax bracket in retirement that you were in when you were working. This could happen if your only source of cash in retirement is from taxable withdrawals from your retirement accounts. Since you deferred taxes when you contributed, Uncle Sam will want his share now that you’re making withdrawals.

You can reduce this problem by adding nonretirement accounts to your long-term savings. These are just regular bank or mutual fund accounts that are not inside IRAs. With these accounts, you’ll owe taxes on your earnings as you go—they’re not tax-deferred—but in retirement you’d have cash available for lump-sum purchases without having to draw from your IRA and pay taxes.

Contributing money to your IRA even when you can’t deduct it on your tax return can be a good retirement income and good tax planning. Your contributions will help grow your nest egg, your investment growth is still tax-deferred until you withdraw money and—probably the biggest benefit—your non-deductible IRA will contain the principal contributions you made, called your IRA basis, that you can withdraw tax-free in retirement. The amount you contribute to your IRA but don’t get to deduct is called your “IRA basis.” When you take money out of your IRA to pay for retirement living expenses, you don’t pay tax on it again. You only pay tax on the money that was earned by the investments, not on the dollars you originally contributed. You still pay income tax rates on your withdrawal, but because part of your withdrawal is tax-free, your overall tax cost will be lower.